Subtraction: Sub-part F Income
September 8, 2020
Re: § 58.1-1821 Application: Corporate Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the corporate income tax assessments issued to ***** (the “Taxpayer”) for the taxable years ended May 31, 2014 and 2015. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer filed consolidated federal corporate income tax returns and separate returns for Virginia tax purposes during the taxable years at issue. It reported net operating losses (NOLs) for years prior to the 2013 taxable year. The Taxpayer carried the losses forward offsetting its federal taxable income (FTI). The Department adjusted the net operating loss deductions (NOLDs) to reflect limitations on loss carryovers after an ownership change as reported on its federal returns, resulting in the assessments.
The Taxpayer appealed, contending that the loss carryover limitations reflected consolidated amounts, and there were sufficient NOLs on a separate corporation basis to offset the FTI of the taxable years at issue. In addition, it asserts that the Department did not include the NOL carryovers of several affiliated companies that were absorbed into the Taxpayer prior to the taxable years at issue. Finally, the Taxpayer argues that a subtraction of Subpart F income for the taxable year ended May 31, 2013 was erroneously disallowed.
DETERMINATION
NOLD Carryforward Limitation
Generally, Virginia income tax law does not address the NOLD. Nonetheless, Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Because Virginia starts its computation of corporate income tax with federal taxable income (FTI), the Department allows an NOLD to the extent it is allowable in computing FTI as calculated for Virginia income tax purposes.
Title 23 of the Virginia Administrative Code (VAC) 10-120 325 provides the methodology that a corporation must use to calculate the NOLD carrybacks and carryforwards for purposes of corporate income tax. Under this regulation, a Virginia NOLD modification must be determined for the taxable year in which an NOL occurred. This Virginia NOLD modification must be carried back and forward in the same manner as the NOLD.
Fixed date conformity additions (FDCA) and subtractions (FDCS) are not considered Virginia modifications. Rather, these exceptions identified in Virginia Code § 58.1-301 are added to or subtracted from FTI as computed under the IRC in order to determine a corporation’s FTI for Virginia income tax purposes. See Public Document (P.D.) 16-22 (3/8/2016). A corporation’s Virginia FTI is calculated by starting with FTI as reported on the federal income tax return, adding the FDCA, and then subtracting any FDCS. The formula for determining Virginia FTI would be as follows:
FTI + FDCA - FDCS = Virginia FTI
For Virginia income tax purposes, a corporation will have an NOL only if the formula results in a number that is less than zero. If FDCA exceeds the total of a loss reported on a federal return plus FDCS, the corporation will not have an NOL for Virginia income tax purposes. Conversely, if FDCS exceeds FTI plus FDCA, the taxpayer will have NOL for Virginia even if it does not report an NOL on its federal return. Such an NOL can be carried back and forward in accordance with the rules established under IRC § 172, except for the five year carryback allowed under IRC § 172(b)(1)(H). See Virginia Code § 58.1-301 B 2.
Under IRC § 382, loss carryovers that can be used annually to offset taxable income are subject to limitations when certain types of corporation ownership changes occur. If a corporation has a NOL or a NOL carryover in a taxable year in which there is an ownership change, it may offset the income in subsequent years by pre-change loss carryovers only to the extent of a IRC § 382 limitation. This limitation is equal to the value of the loss corporation immediately before the ownership change multiplied by the long-term tax exempt rate. See IRC § 382(b)(2).
In this case, a number of related entities reported an ownership change in 2011, triggering the IRC § 382 loss limitations reported on the federal returns. Title 23 VAC 10-120-100 B 5 v provides that “[m]embers of an affiliated group of corporations which file a consolidated federal return and separate or combined Virginia returns must compute federal taxable income and the NOLD as if each corporation had filed a separate federal return for all affected years.” Thus, IRC § 382 NOLD limitations reported on the consolidated federal returns may not be the same as the NOL carryovers that must be determined for Virginia income tax purposes on a separate company basis.
Subsidiary NOL Carryovers
The Taxpayer indicates several companies that had NOL carryovers were merged into it prior to the taxable year at issue, and the Department did not include those losses in its NOLD adjustments. In P.D. 96-38 (4/5/1996), the Department determined that any NOLs of merged corporations will be available to the surviving corporation if allowed under the IRC. Under IRC § 381(a) and (c), a successor corporation carries over certain tax attributes after certain corporate acquisitions, including carryover items. To the extent permitted under the IRC, the NOLs of companies merged into the Taxpayer in years prior to the taxable years at issue should be included in the Department’s adjustment to the Taxpayer’s NOLDs.
According to the auditor, returns and schedules requested during the examination to verify the amounts reported were not available or provided. Without verifying documentation, the auditor used available records to adjust the NOLDs and NOLD carryovers as permitted under Virginia Code § 58.1-111.
Subpart F Subtraction
The Taxpayer contends that the Department did not allow a subtraction for Subpart F income on its Virginia corporate income tax returns as a Virginia modification for the 2014 taxable year. Pursuant to Virginia Code § 58.1-402 C 7, income included in federal taxable income pursuant to IRC § 951, less attributable expenses, is subtracted in determining Virginia taxable income. Also see Title 23 VAC 10-120-102 G and P.D. 93-56 (3/5/1993). The Department acknowledges the denial of the subtraction was an oversight.
CONCLUSION
Thus, IRC § 382 NOLD limitations reported on the consolidated federal returns may not be the same as the NOL carryovers that must be determined for Virginia income tax purposes on a separate company basis. As such, the NOL carryovers must be adjusted to reflect that the NOLDs be computed on a separate company basis. Further, the Subpart F subtraction modification for the 2014 taxable year was erroneously omitted in the NOL carryover computation.
The Taxpayer, however, did not provide sufficient documentation to the auditor to support the inclusion of the former subsidiary corporations’ NOLs. In addition, the Taxpayer indicates that it did not incorporate Virginia modifications as required by Title 23 VAC 10-120-100 B 5 in its NOL carryback and carryover computations.
Accordingly, the case will be remanded to the Department’s auditor to adjust the NOLD carryovers to reflect the IRC § 382 loss limitations on a separate return basis. The auditor will contact the Taxpayer and arrange to review the documentation needed to include the subsidiary corporation’s NOLs in the Taxpayer’s NOL carryovers. Such documentation must include the Virginia modifications as required by Title 23 VAC 10-120-100 B 5. Any information that the auditor requires must be provided within 60 days of the date of the request. If the requested documentation is not received within the allotted time, the assessments will be adjusted based on the information available.
The Code of Virginia sections, regulations, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/2088.B